As a partner in a company the need for a partnership buyout may occur for any number of reasons. Perhaps there is a change in the goals or direction of the company, retirement, health reasons, or simply a partner moving on in another career direction. No matter the reason, a partnership buyout requires some thought and advance preparation for both parties.
Financing a partnership buyout has always been a challenge. However, an SBA loan is an excellent source of funds in a partnership buyout. Recently the rules that govern buyouts utilizing SBA financing have changed making it easier to accomplish the transfer in ownership. But importantly there are rules that you will need to be aware of when structuring the transaction.
SBA SIMPLIFIED PARTNERSHIP BUYOUT LOANS
Prior to 2018, SBA required the company’s balance sheet to have a minimum of 10 percent equity based on the business’s total assets after the sale. This was hard to accomplish without requiring the buying partner (borrower) to bring in additional funds, since most equity was utilized in the buyout. Now, under the new SBA ruling, a partner can accomplish the buyout without investing any of their own funds. In other words — 100 percent financing. There are certain criteria that will need to be met. First is the debt to net worth calculation on the most recent year-end balance sheet and the most recent current balance sheet. This ratio must be below 9:1.
Here is an example of how to make the calculation:
| Business Assets: | $2,000,000 |
| Business Liabilities: | $400,000 |
| Equity: | $1,600,000 |
| Debt to Equity Ratio | 1:4 |
This example demonstrates that the ratio is below 9:1 thus meeting the criterion for SBA without requiring the buying partner to put down additional funds. The buyer would simply utilize and leverage the equity on the balance sheet.
The second criterion that must be met is the buying partner’s ownership must have been the same or greater for the previous two years and he must have been actively involved in the business.
FORM OF BUYOUT
There are a number of possibilities in a buyout including:
• Earn out
• Lump sum
Earn-out — meaning buying out the exiting partner over a period of time — is not allowed under the SBA loan. The buy-out must be 100 percent or lump sum to be eligible for SBA financing. Additionally, the exiting partner cannot remain in the company with any ownership interest or have any involvement in the company as an officer, director, or employee. However, the selling partner can be retained and paid as a consultant for up to 12 months after the buyout.
Of additional importance: should the buyout involve a spouse in a divorce proceeding, the divorce agreement will be key. But again, with the new SBA rules the spouse can leverage the business in the buyout without utilizing cash, just the same as buying out any other partner.
Consult with a CPA and Attorney
Consult with your CPA and attorney regarding the buyout. There will be several things to consider with the attorney(s) preparing the buyout agreement. Often, the first order of business will be the agreement among the parties as to the value of the business (most likely requiring a third-party evaluation). Recognize also that a lender will need to order a third-party business valuation to substantiate the value.
BENEFITS OF THE SBA 7(a) LOAN
• Loan is amortized over 10 years
• SBA fees may be financed instead of paid out of pocket
• There are no SBA loan covenants
• Rates are competitive with conventional lending
• If commercial real estate is involved in the sale, the amortization possibly could be 25 years. Discuss this with your lender
BE PREPARED FOR A LENDER
Here’s what you will need:
Personal:
• Personal financial statement
• Three years’ personal tax returns
• Liquidity documentation
Business:
• Three years’ tax returns
• Year to date profit and loss and balance sheet
• Debt schedule
CHOOSING A LENDER
There are numerous lenders that participate in the SBA lending program. Some lenders have the designation “Preferred” or “PLP.” These lenders have delegated authority to approve loans internally for SBA.
Some people think obtaining an SBA loan is difficult and can take “forever to close.” This impression comes from either an unpleasant experience in the SBA process or perhaps working with a lender that does not specialize in SBA lending. There is no doubt that SBA loans come with many rules, but working with an experienced SBA lender who will navigate the process for you can make the difference. You and your lender should be a “team.”
No matter the reason for parting ways with a partner, it is advisable to discuss the transaction with an SBA lender to assist with any advance advice on the financing.
Brenda Bevilacqua is a seasoned SBA Lender with 25 years of experience with national banks and non-bank lenders. She represents VelocitySBA, a nationwide SBA Preferred Lender (PLP). Brenda can be reached directly at 602-692-7220 or bbevilacqua@velocitysba.com.